Financial Institution Advantage and the Optimization of Information Processing

Chapter 9Case Studies

In this chapter, we look at some examples of specific firms that lost or gained some competitive advantage through choices they made about how to prioritize and manage their information processing capabilities. Recent history provides a long list of model failures within the financial services industry that were high profile, high impact, or both. These include Long-Term Capital Management in 1998 (which failed largely due to faulty assumptions in its convergence trading model), Standard & Poor's (S&P) in 2008 (which discovered an error in a model for rating complex debt products but said that the error did not directly affect any ratings), Moody's in 2008 (which also discovered an error in its model for rating complex debt products and acknowledged that the error did affect certain ratings), Knight Capital Group in 2012 (whose trading software malfunction led to more than $450 million of losses and drove the firm into insolvency), Goldman Sachs in 2013 (whose software glitch caused an erroneous flood of stock options orders, many of which had to be cancelled, creating significant trading losses), Bank of America in 2014, as well as many others. The point of this chapter, however, is not merely to catalog the impacts of information system failures. After all, any firm that uses models in any material way exposes itself to model risk, and we certainly do not want to suggest that model risk is inherently bad. Quite to the contrary, our whole premise is that ...